Capital One: Earnings Season Winner

NEW YORK ( TheStreet) -- Capital One Financial ( COF) was the winner among large-cap U.S. bank stocks on Friday, with shares rising 1.6% to close at $71.92.

Capital One is set to announce its third-quarter results on Oct. 17, with analysts polled by Thomson Reuters on average estimating the card lender will report net income of $978 million, or $1.75 a share, compared to EPS of $1.74 a share the previous quarter and $2.01 a year earlier.

The company's shares trade for 10.5 times the consensus 2014 EPS estimate of $6.85. For more on Capital One, please see TheStreet's recent coverage of Bargain Credit Card Stocks.

The broad indices all showed solid gains on Friday, as investors continued to wait for agreements in Washington to raise the federal debt limit and to allow the government to restore full services.

The KBW Bank Index ( I:BKX) rose 0.4% to close at 63.58 as investors digested a very complicated start to third-quarter earnings season.

Third-Quarter Earnings Kick-Off

JPMorgan Chase ( JPM) and Wells Fargo ( WFC) traditionally begin earnings season for large-cap banks and did so on Friday. But before the party started, SunTrust ( STI) late on Thursday announced a serious of negative mortgage items expected to wipe out roughly half of its third-quarter net income.

SunTrust of Atlanta announced over $1 billion in extraordinary third-quarter mortgage related items, a settlement of claims by the Federal Housing Administration, with the bank agreeing to pay $500 million in "consumer relief" and make a $468 million cash payment.

SunTrust also announced loan repurchase claim settlements with Fannie Mae ( FNMA) and Freddie Mac ( FNMA), which resulted in cash payments of roughly $268 million after credits for previously repurchased loans were deducted. The bank also was required to pay a $160 million fine to the Federal Reserve under the national mortgage settlement.

The bank said it would also take a $96 million charge related to the sale of mortgage servicing rights.

The above items were partially offset by a tax benefit of $113 million, following a "taxable reorganization of certain subsidiaries during the third quarter."

SunTrust said the multiple items would lower its third-quarter earnings after taxes by $179 million, or 33 cents a share. Prior to the announcement, the consensus among analysts polled by Thomson Reuters was for the bank's third-quarter earnings to come in at $372 million, or 68 cents a share.

SunTrust's shares rose 0.5% on Friday to close at $41.43. The company will announce its full third-quarter results on Oct. 17.

JPMorgan Chase's Surprise

The nation's largest bank by assets early on Friday reported a third-quarter net loss of $380 million, or 17 cents a share, declining from earnings of $6.5 billion, or $1.60 a share in the second quarter, and $5.7 billion, or $1.40 a share, during the third quarter of 2012.

Investors knew JPMorgan Chase's earnings would decline, because of the bank's three major regulatory settlements during the third quarter, including an agreement to pay $410 million "in penalties and disgorgement to ratepayers," to settle Federal Energy Trading Commission charges of market manipulation, $920 million in fines to settle multiple probes of the 2012 "London Whale" trading fiasco and another $369 million in fines and customer refunds to settle regulatory charges of " illegal credit card practices."

But investors have been waiting for "the big one," which is expected to be a global settlement of multiple criminal and civil investigations of JPMorgan's mortgage lending and sales activities by the Department of Justice, federal regulators and states' attorneys general. Various media reports have estimated the settlement -- possibly delayed by the partial shutdown of the federal government -- could reach as high as $11 billion.

JPMorgan took a forward approach by setting aside $9.15 billion for litigation reserves during the third quarter, which lopped of $7.20 billion, or $1.85 a share, from after-tax earnings.

The company increased its transparency by reporting its litigation reserves totaled roughly $23 billion as of Sept. 30, with a "range of reasonably possible losses" up to $5.7 billion beyond what is currently reserved. Those are huge figures, but the relatively strong market reaction to the announcement shows that investors are comfortable that further losses will have little effect on JPMorgan's financial performance in 2014. JPMorgan set earnings records over the past three years of $17.4 billion, or $3.96 a share in 2010; $19.0 billion, or $4.48 a share, in 2011; and $21.3 billion, or $5.20 a share, in 2012.

JPMorgan's shares were down a penny to close at $52.51. The shares remain among the cheapest for bank stocks, valued at just 8.8 times the consensus 2014 EPS estimate of $5.99, among analysts polled by Thomson Reuters.

Wells Fargo Continues Record Streak

Wells Fargo is now the nation's most profitable bank, and on Friday posted record earnings of $5.578 billion, or 99 cents a share, for the third quarter. In comparison, the company earned $5.519 billion, or 98 cents a share, in the second quarter, and $4.937 billion, or 88 cents a share, during the third quarter of 2012.

The company's earnings were boosted by a "$900 million loan loss reserve release due to continued strong credit performance and improved housing market." It would appear from the company's credit numbers that additional significant releases of loan loss reserves are coming.

Wells Fargo reported nonaccrual loans of $16.893 billion, or 2.08% of total loans, as of Sept. 30, improving from 2.23% the previous quarter and 2.44% a year earlier. Meanwhile, the bank's annualized third-quarter ratio of net charge-offs to average loans was just 0.48%. Reserves covered 1.93% of total loans as of Sept. 30.

Heading into third-quarter earnings season, investors' main concern was declining trading revenue and a major drop in mortgage banking revenue, as higher rates have slowed the mortgage refinancing wave.

Wells Fargo's total third-quarter revenue was $20.478 billion, declining from $21.378 billion the previous quarter and $21.213 billion a year earlier. Mortgage banking revenue for the third quarter dropped to $1.608 billion from $2.802 billion in the second quarter and $2.807 billion in the third quarter of 2012.

In addition to a sharp decline in loan origination volume, the mortgage revenue decline reflected a decline in the gain-on-sale margin for loans sold to Fannie Mae and Freddie Mac, brought about by rising long-term interest rates. During Wells Fargo's third-quarter conference call, CFO Tim Sloan said the bank's gain-on-sale margin "declined from the historically high levels we experienced for the past year to 1.42%," in the third quarter from 2.21% in the second quarter.

Wholesale banking revenue declined to $5.871 billion in the third quarter from $6.135 billion in the second quarter and $5.949 billion in the third quarter of 2013. The sequential decline in wholesale banking revenue reflected "sales and trading and investment banking results as well as seasonally lower crop insurance fees," according to the company.

Revenue within Wells Fargo's Wealth, Brokerage and Retirement segment grew to $3.307 billion in the third quarter from $3.261 billion the previous quarter and $3.033 billion a year earlier.

Jefferies analyst Ken Usdin rates Wells Fargo a "buy," with a price target of $48, and in a note on Friday wrote "the core looks touch soft with net interest income flat," and that the company's expenses were "a bit higher-than-expected."

Wells Fargo's third-quarter net interest margin -- the spread between the average yield on loans and investments and the average cost for deposits and borrowings -- narrowed to 3.38% during the third quarter from 3.46% in the second quarter.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

If you liked this article you might like

Citigroup boosted CEO Michael Corbat's pay to $23 million, even as the bank failed to meet the CEO's own profitability goal for a third straight year, and as it reported a full-year net loss of $6.2 billion due to the write-off of tax credits that management had touted as a competitive advantage.

Last week's market drop rattled investors with concerns about rising inflation and interest rates. Yet with the economy progressing at a slower pace than in past cycles, there's plenty of time left to profit from bank stocks like JPMorgan, Bank of America and Citigroup, typically among the biggest beneficiaries of economic growth, argues Sandler O'Neill.